Millionaire Mommy Next Door recently posted a series on renting vs buying which was quite interesting. She takes the view that renting can be much more financially rewarding than home ownership and gives her own situation as the example. While I don’t disagree that she has improved her lifestyle by renting, she makes it sound like home owners can’t participate in equity markets which is a bit ridiculous. On the other hand some of the commenters take the opposite tack and say that the only way to win at real estate (or to save) is to own a house.
There is no difference between renting and buying
I would argue that theoretically there doesn’t have to be any economic difference between renting and buying. Ideally both renters and home owners should be invested in equities and real estate and will benefit if either investment class does well.
Renters could include more REITs (such as VNQ) or investment properties in their asset allocation so they have some real estate exposure to make up for the fact that they don’t own a house. Another strategy that a renter can follow if they want to keep up with their house-owning friends is to use leverage to buy equities so that they can have a large monthly payment as well. If your best friend buys a house and has a $250k mortgage then you (a renter) can go out and borrow $150k and buy equities. The renter can expect a higher rate of return from equities and therefore doesn’t need to borrow as much as the home owner. This way you can still remain best friends and commiserate together about not having enough money.
Don’t overspend on the house
The reality is that when we rent, we tend be fairly moderate in our demands since we know that all of the rent payment is a cost and nothing is going towards our equity. When buying a house, a lot of us buy as big as possible and ignore the huge interest costs, focusing instead on the small (in the beginning at least) amount of equity we are building. A comment such as “At least I’m building equity instead of throwing my money away on rent” would only be true if the amount of interest on the mortgage plus maintenance and property tax was equal to the amount of rent being paid which it usually isn’t.
What to do if you are a homeowner?
- Only buy as much house as you can afford and still be able to save money so you can invest in equity markets.
- Pay down your mortgage at a reasonable rate – 20 years maximum. In case your house value goes down the more equity you have (had) the better off you will be. If your house value goes up then you are still better off with less mortgage.
What to do if you are a renter?
- Save as much as you can (more than the home owner) and increase your asset allocation in real estate investments such as REITs. You could also buy rental properties although that’s another ball game altogether.
- If you really want to emulate the home owner experience without actually buying a home then consider using leverage to buy equities since that’s the reason home owners have done so well in the rising real estate market. Extreme caution should be used with leverage.
- Don’t feel like you are being left behind. I honestly believe that a renter has more financial options than a home owner. The trick is to make sure you take advantage of those opportunities.